Many parents want to ensure that their kids are financially secure after they pass away. However, figuring out the guidelines and available options for what your parents have left for you is the last thing on your mind when they pass away.
There’s a lot to know if your parent left you an individual retirement account (IRA). While you’re grieving, it may seem impossible to understand the regulations and implications, but this breakdown gives you the knowledge you need to choose the course of action that will work best for you.
Navigating the complexities of inheriting an IRA from a parent can be overwhelming, especially during a time of grief. This guide provides clarity on the tax implications, distribution options, and steps you can take to make informed decisions.
Tax Implications:
- Roth IRA: Distributions from inherited Roth IRAs are tax-free, provided the account is at least five years old and meets specific requirements.
- Traditional IRA: Withdrawals from inherited traditional IRAs are taxed as ordinary income. However, if the estate paid estate taxes on the account, the beneficiary receives an income tax deduction for those taxes.
Distribution Options:
- Lump-Sum Withdrawal: Withdraw the entire IRA balance in one go. This option triggers immediate taxation on the taxable portion and may push you into a higher tax bracket.
- Inherited IRA: Transfer the funds into a new inherited IRA account. This allows for tax-deferred growth and spreading distributions over multiple years, potentially reducing your tax burden.
Steps to Take:
- Understand Your Beneficiary Status: Determine whether you’re a designated or eligible designated beneficiary. This impacts your distribution options and timelines.
- Seek Professional Guidance: Consult a financial advisor to understand the nuances of your specific situation and make informed decisions about managing the inherited IRA.
- Choose a Distribution Strategy: Decide whether a lump-sum withdrawal or an inherited IRA aligns better with your financial goals and tax considerations.
- Open an Inherited IRA (if applicable): Work with a financial institution like Thrivent to establish an inherited IRA and transfer the funds according to IRS regulations.
- Manage Distributions Carefully: Follow the required distribution rules based on your beneficiary status and the original account owner’s date of death.
Additional Considerations:
- Creditor Protection: Inherited IRAs do not offer protection from creditors in bankruptcy, unlike traditional IRAs.
- Estate Planning: Consider incorporating the inherited IRA into your estate plan to ensure its efficient distribution to your beneficiaries.
Inheriting an IRA from a parent requires careful consideration and informed decisions. By understanding the tax implications, distribution options, and available resources, you can navigate this process effectively and make choices that align with your financial goals and future plans. Remember, seeking guidance from a financial advisor can provide invaluable support and ensure you make the most of this inheritance.
Frequently Asked Questions:
1. What happens to an inherited IRA if the beneficiary dies?
The inherited IRA becomes part of the beneficiary’s estate and will be distributed according to their will or trust.
2. Can I combine multiple inherited IRAs into one account?
Yes, you can consolidate multiple inherited IRAs into a single account for easier management.
3. How do I avoid penalties when withdrawing from an inherited IRA?
Follow the required distribution rules based on your beneficiary status and the original account owner’s date of death.
4. Can I contribute to an inherited IRA?
No, contributions to inherited IRAs are not allowed.
5. Where can I find more information about inherited IRAs?
The IRS website provides detailed information about inherited IRAs, including distribution rules and tax implications.
Additional Resources:
- IRS Publication 590-B: Distributions from Individual Retirement Arrangements (IRAs)
- Thrivent: How to Navigate Inheriting an IRA from a Parent
- Charles Schwab: Inheriting an IRA: Understand Your Options
By understanding the complexities of inheriting an IRA from a parent and taking proactive steps, you can ensure a smooth transition and make informed decisions that benefit your financial future.
Understanding the taxes on inherited IRA from parent
You probably want to know how you will be taxed on an inherited IRA first. The response varies based on the kind of IRA you have and your goals for it:
- Roth IRA. Qualified distributions from Roth IRAs are not taxable. This includes inherited Roth IRAs. But the five-year rule still stands: If the initial Roth contribution was made less than five years ago, the gains are subject to taxation.
- Traditional IRA. Distributions from this kind of IRA are included in your income and subject to appropriate taxation. If there is an after-tax balance in the IRA, the withdrawal of this amount is not subject to taxes. There is no early withdrawal penalty no matter your age.
Distributions from an inherited IRA
Depending on the date of death of the original account owner and whether you are regarded as a designated beneficiary or an eligible designated beneficiary, you might be subject to different sets of rules.
Unless one of the following circumstances exists (in which case you would be deemed an eligible designated beneficiary), you are regarded as a designated beneficiary if you are inheriting an IRA from a parent:
- Minor children of the original owner
- People who are chronically ill
- People who are permanently disabled
- Individuals who are younger than the original owner by less than ten years
A minor child who inherits the account will be regarded as a qualified designated beneficiary until they become an adult.